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Financial Federal Corporation (NYSE:FIF)

F4Q08 Earnings Call

September 25, 2008 11:00 am ET

Executives

Paul R. Sinsheimer –Chief Executive Officer

Steven F. Groth – Chief Financial Officer

David H. Hamm –Controller

Analysts

Sameer Gokhale – Keefe, Bruyette & Woods

John Hecht – JMP Securities

Scott Valentin – FBR Capital Markets

Operator

Welcome to the fourth quarter 2008 Financial Federal Corporation earnings conference call. (Operator Instructions)

This call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and are subject to risks and uncertainties that could cause actual results to differ materially from those contained in the forward-looking statements. Readers are referred to the most recent reports on forms 10-K and 10-Q filed by the company with the Securities and Exchange Commission that identifies such risks and uncertainties.

I would now like to turn the presentation over to Paul Sinsheimer, Chief Executive Officer.

Paul R. Sinsheimer

Joining me are Steve Groth, our CFO, and David Hamm, our Controller. I will briefly discuss our fourth quarter and year end results and business trends. I will then ask Steve to discuss liquidity, then we will take questions from participants.

As to the fourth quarter, net income ending 7/31/2008 was $12.1 million, 4% lower than last quarter. Diluted earnings per share was $0.49 for the quarter, 2% lower than the previous quarter. Originations for the quarter were $208 million compared to $232 million in the third quarter. Finance receivables declined approximately 4% during the fourth quarter. Net interest margin declined to 5.67% from 5.79% in the third quarter. Expenses were $7 million in the third quarter compared to $6.9 million in the third quarter. Also, we announced our quarterly dividend $0.15 per share unchanged from the prior quarter and the board also approved increasing our stock buyback program to $50 million.

Performance for the year: net income for fiscal year ending July 31 was $50.1 million, slightly higher than the prior year. Earnings per share was $2.01, a 6% increase from the prior year. Originations for the year were $920 million compared to $1.21 billion at July 31, 2007. The yield for fiscal 2008 was 9.14% down from 9.25% in 2007, and our interest costs went down from 5.36% to 4.75%. This resulted in an increased margin from 5.15% to 5.48% year to year.

Expenses for the year were $27.3 million compared to $24.9 million the previous year. This increase resulted mostly from higher non-performing asset costs. Put all together, this resulted in approximately 12.5% return on equity, 2.5% return on assets, and a 3.5 debt to equity ratio. Asset quality net charge offs were $3.2 million in fiscal 2008 compared to $108,000 in fiscal 2007. At 7/31, non-accruals were 1.73% of total receivables, up from 0.88% the previous year. Delinquencies also increased to 1.18% from 0.46%, repossessions increased to 0.68% from 0.11%.

Steven F. Groth

Our funding strategy remains the same. We continue to employ diverse sources of capital, staggered maturities, and to date, we are very comfortable with our strong liquidity position. We continue to look for additional sources of capital and most recently renewed a $30 million unsecured bank facility for two years.

Paul R. Sinsheimer

It has been almost four months since our last earnings call and during that time the financial world has experienced one of its worst crises since a lot of people want to say the Great Depression anymore, I’ll just say in my lifetime. The crisis is not over and it is changing the financial landscape of the US economy. How the world will look when the storm passes is difficult to determine. To date, and on a relative basis, Financial Federal has done better than most in weathering this storm. At year end we had over $350 million of available liquidity. Receivables were down $188 million or approximately 9% lower than the year before. However, our net income was actually higher in fiscal ’08 than in ’07. I don’t believe there are many that can make that statement. I believe we have put ourselves in a powerful position. We are poised to take advantages of opportunities that may become available as the financial world reassess its risk as well as its priorities. We have very low leverage, very sound business model, transparent accounting, no sub-prime or [alta] mortgages, sufficient liquidity, and most importantly, an outstanding group of managers who are very good at what they do. I’m as comfortable as I can be given the difficult times we are in.

At this time I would like to open the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Sameer Gokhale – Keefe, Bruyette & Woods.

Sameer Gokhale – Keefe, Bruyette & Woods

You talked about potentially looking at opportunities, it seemed like acquisition opportunities. I was just wondering to what extent that might include potentially buying a bank. It seems if anything this cycle has taught us the importance of deposit funding when the wholesale funding markets are in turmoil. Is that something that you’ve considered or are considering, why or why not?

Paul R. Sinsheimer

Sameer, I think that’s a great question and if I were to answer it in the negative, that no we are not, I probably would be the only one in the country not looking to do that. Let me say this, we are exploring all of the opportunities and that is one. We’re under no time clocks or severe time clocks or to do so but as the world continues to turn and things continue to change and evolve, we are considering all of these options and it’s on the table along with several other things.

Sameer Gokhale – Keefe, Bruyette & Woods

Can I ask you if you’ve already had a discussion with the bank regulators as far as this is concerned?

Paul R. Sinsheimer

I’m not going to go into that type of detail except to say that we are certainly intellectually and physically approaching this and as things become more definitive we will share them with the public at an appropriate time.

Sameer Gokhale – Keefe, Bruyette & Woods

Okay, fair enough, and then the other question I had was, you talked about in the past as well, the operating expenses, and how they relate to higher MPAs, but it seems like if one were to look at the run rate of OpEx, that your operating expenses are kind of $500,000 or so higher as compared to say the same period last year and I was wondering if you could just shed some light on what exactly, how that relates to the increased MPA, are those the costs for just locating and repossessing the actual assets? Can you shed some light on that?

Paul R. Sinsheimer

This is a phenomena we experienced 5 or 6 years ago or 4 years ago in 2003 when we experienced a downward swing in our business. We expense all of our repossession and litigation expenses as incurred. They’re not capitalized. They are written and they are charged to earnings as paid. As you can see, we went from net losses at microscopic levels to something that I still consider outstanding but meaningfully larger and those costs are litigation and repossession costs and that is a very, very large portion of that increase and as the portfolio, if it continues to weaken, you can expect those costs to remain with us. Once again, when it turns, and if our performance in the future is similar to what it was in ’04 and ’05, you actually saw our operating expenses come back down as we’re able to collect those monies that were previously expensed. It is a moving target but in general as the portfolio declines, those costs go up, and when it turns, we usually get a large portion of that money back.

Sameer Gokhale – Keefe, Bruyette & Woods

That’s helpful, now I just want to get some better sense for any repossess, some sort of equipment, on average, what would be the litigation costs on that piece of equipment versus the actual repossession costs of that? If you have some sort of breakdown... I’m just trying to get some sense for it given the rate of increase.

Paul R. Sinsheimer

Regretfully, first of all as to legal expenses, most of the time legal expenses on a $100,000 piece of litigation can equal those on a $1 million piece of litigation, so legal costs are not driven by the size of the money involved. Repossession costs can be all over the board depending on the complexity of the asset being repossessed. In some cases it can be several hundred dollars, in other cases it can be $10,000 or $15,000. It just depends on the nature of the asset and the difficulty of taking possession of it, so it’s impossible for me to answer your question directly.

Sameer Gokhale – Keefe, Bruyette & Woods

That’s still helpful. My last quick question was that I noticed that FIF was not on that “do not short” list by the SEC and I was wondering if you asked to be put on there or why you weren’t on that list, if you have any thoughts on that.

Paul R. Sinsheimer

No, we are not on that list, and no we have not asked to be put on that list, and no, we don’t think there’s any reason to be on that list. I think that our stock price once again relative to the group has held up remarkably well but I think there’s a reason for that, and that reason is there’s no mystery to our assets, there’s no mystery to our income, and there’s no mystery to our business. The accounting is straightforward, it’s as rudimentary as it can possibly be, and there is no reason to single us out for a negative result much larger than the general economy. But that doesn’t say that we couldn’t be shorted. We’re very comfortable with where we’re at, let me just put it that way.

Sameer Gokhale – Keefe, Bruyette & Woods

That’s great. I just wondered if you’d asked to be put on there and if for some reason you weren’t allowed to be put on there. It sounds like you never asked to be put on the list, so that’s very helpful.

Operator

Your next question comes from John Hecht - JMP Securities.

John Hecht – JMP Securities

Paul, I’m wondering, can you maybe give some color on the business lines? I guess particularly commercial construction, what you’re seeing out there, maybe from a regional perspective.

Paul R. Sinsheimer

That’s a great question. Regionally there are not too many moving parts that are worth commenting on at this time but I will tell you that it’s senior management’s belief that the turmoil that is currently going on Wall Street will most certainly find its way to Main Street in the not too near distant future. You can tell especially in the last several weeks, John, there’s a much more heightened awareness of what’s going on in the financial world on Main Street. To say hesitancy may even be understating the realities, people that manage their business and do it appropriately focus on things that are going to affect them and I believe until very recently most of the non-Wall Street world believed this was contained and not going to affect them and they are at least today currently reassessing that position. If Washington doesn’t get its act together, I think it’s safe to say that things could get pretty ugly in many places, not only Financial Federal’s business.

John Hecht – JMP Securities

I guess historically if you look at your business lines as we go through these credit cycles like we may be entering right now, which business in reflection of I guess transportation, waste, which appears to be more stable than construction, which businesses do you see getting impacted the quickest and recovering maybe early in the cycle, and which will take time to roll through the business lines?

Paul R. Sinsheimer

Well we’ve already started to see it in transportation. I don’t think transportation is going to get worse, but I certainly don’t want to be encouraging in telling you it’s made a u-turn in getting better, I just don’t think it’s getting worse. Construction, we’re in commercial projects that have extended lives and duration. We all read about the dislocation in the commercial property markets and you can only assume that will eventually blow into whether new projects are done or not done. We continue to see asset prices that are firmer than one would expect. How long that stays that way is pretty difficult to determine. We’re not overly positive based upon what we see today. Let me add to that: we get a package out of Washington that the world embraces, understands, and supports, I think that could turn my perspective very quickly, and so to give you any guidance, I could give you serious guidance today at 11:00 only wanting to retract it at 4:00 today, so I’m hesitant to do so. All I can tell you is we’re trying to remain flexible, flushed with cash, and we intend to be opportunistic at the right moment.

John Hecht – JMP Securities

On that last point there in terms of liquidity, Steve, could you maybe could you give us a sense of... It sounds like you’ve improved your position of liquidity or at least capacity. Can you kind of give us a sense for how that breaks down between banks and facilities and the securitization conduit at this point?

Steven F. Groth

Well, it’s very diversified, it is very similar to what you would see back in April at our third quarter end. All I was doing was rolling out maturities now. One bank had come due and we renewed that for two years, but that’s a minor portion of this. The balance of our maturities are long term, very little coming due, none in ’08 and very little coming due in ’09. We have the term out on the securitizations which are down to $160 million and we still have the $325 million that is one year renewal and then it has the term out if we were to use it, but we’re in, as you would suspect, CP is down unsecured, CP is down given the markets, and we opportunistically go in and our financing under our bank lines and again, opportunistically choosing whether it’s overnight, one week, or 30 days the way LIBOR is jumping around today. So we have a lot of flexibility.

Operator

Your next question comes from Scott Valentin - FBR Capital Markets.

Scott Valentin – FBR Capital Markets

Regarding your origination volume, is it a question of maybe tightening underwriting standards and therefore you’re pulling back or are you just cautious on the overall outlook, or is it just that competition remains pretty intense?

Paul R. Sinsheimer

I would say you could say a certain portion of all of the above. There are times that underwriters can feel aggressive and more positive in there are times when they feel less positive and less aggressive. I would suggest we are less positive and less aggressive today in balancing the risk and reward. I’ll also say to you that business activity in general has slowed and there are fewer competitors for our assets today than there were a year ago but the remaining competitors that are there are just as intense. So it’s really a combination of all of the above, Scott.

Scott Valentin – FBR Capital Markets

And with regard to recovery values, there’s some concern of we’re seeing some signs of maybe a global slowdown, and I think one of the traits that was supporting recovery values was demand from overseas. Any thoughts on maybe where recovery values are, are they softening or have you seen that yet or do you expect that?

Paul R. Sinsheimer

I expect it. I’m not seeing it yet. Once again, we believe we’re very conservative underwriters. We’re not prone to stretching terms or getting beyond a pragmatic approach. I’m very comfortable with the underwriting and I’m very comfortable with the collateral values. We’re just not as liberal today as we might have been a year ago.

Scott Valentin – FBR Capital Markets

And then putting aside the potential for deposit funding, looking at the kind of asset liability structure today in terms of, I think most of the assets are fixed rate and most of the liabilities are floating rate, is there any thoughts on maybe adjusting ratios or trying to match the book better in terms of interest rate risk?

Paul R. Sinsheimer

First of all, let me correct you. Steve, what is the fixed and floating?

Steven F. Groth

It’s 91 fixed and 9 floating.

Paul R. Sinsheimer

On the assets.

Steven F. Groth

On the assets and we’ve actually increased the percentage that’s fixed versus floating. I mean, that’s up to 58%.

Paul R. Sinsheimer

On the debt.

Steven F. Groth

On the debt. 58% and 42, and then when you count in equity, it’s two-thirds, one-third. So we’ve actually improved that asset liability mix.

Paul R. Sinsheimer

We have had from the beginning a very little desire to match it. The assets turn very, very quickly as you’ll see when you read our most recent 10-K. We had roughly a 50% turn in receivables in one year. That has always been an integral part of our underwriting strategy together with our funding policy, is to have a very minimal, although real, exposure to turning capital markets.

Scott Valentin – FBR Capital Markets

One final question regarding capital management. You guys kept the dividend at $0.15 flat quarter-over-quarter but you didn’t put aside more capital to buy back stock. What’s the decision process between increasing the dividend versus buying back the stock. Do you just want to retain more flexibility that a buy back provides?

Paul R. Sinsheimer

The simple answer there, Scott, is yes, but it’s not a simple answer. We will try to remain as prudent as we always have in balancing the act between the dividend and share repurchases and there’s no formula that fits that because circumstances change and things change. So it would be impossible to answer your question.

Operator

There are no further questions at this time.

Paul R. Sinsheimer

Thank all of you for attending. We will see you again shortly after our first quarter numbers. Have a good day.

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Source: Financial Federal Corporation F4Q08 (Qtr End 07/31/08) Earnings Call Transcript

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